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U.S. Shifts Focus in Credit Bailout to the Consumer

Treasury Secretary Henry M. Paulson Jr., in Washington on Wednesday, hopes to make it easier for consumers to borrow money.Credit
Brendan Smialowski for The New York Times

WASHINGTON — The Treasury Department on Wednesday officially abandoned the original strategy behind its $700 billion effort to rescue the financial system, as administration officials acknowledged that banks and financial institutions were as unwilling as ever to lend to consumers.

But with a little more than two months left before President Bush leaves office, Treasury Secretary Henry M. Paulson Jr. is hoping to put in place a major new lending program that would be run by the Federal Reserve and aimed at unlocking the frozen consumer credit market.

The program, still in the planning stages, would for the first time use bailout funds specifically to help consumers instead of banks, savings and loans and Wall Street firms.

Treasury officials said they hoped to invest about $50 billion from the bailout fund into the new loan facility, with the aim of helping companies that issue credit cards, make student loans and finance car purchases.

As envisioned, the Treasury would put up about 5 percent of the money that a company would use for lending and private investors would put up perhaps 20 times that much by buying bonds issued by the new program.

Despite the mind-boggling amount of money that Congress has authorized the Treasury to spend — $350 billion immediately, and another $350 billion that Congress would approve under a fast-track procedure — Mr. Paulson is running short of money and time.

The news that the government will not buy soured mortgage assets, along with a string of poor corporate earnings, disheartened investors on Wednesday, sending the markets down for a third straight day this week. The Dow Jones industrial average fell 411.30 points, or 4.7 percent, to close at 8,282.66.

The Treasury has already committed about $290 billion. It has allocated $125 billion to the nation’s nine biggest banks and investment banks; another $125 billion for publicly traded regional banks; and $40 billion to expand the existing bailout of American International Group, the insurance conglomerate that collapsed in September.

Mr. Paulson alluded to the consumer credit plan vaguely in a news conference on Wednesday, and some Fed officials cautioned that they had seen few details. But Treasury officials said such a plan would give them the biggest bang for the buck and might be enacted within several weeks.

Mr. Paulson conceded that he had scrapped the plan he originally sold to Congress in September, which was to have the Treasury Department buy hundreds of billions of dollars worth of illiquid mortgage-backed securities in order to free up banks to resume normal lending.

The program is still called the Troubled Asset Relief Program, or TARP, but it will not buy troubled assets. “Our assessment at this time is that this is not the most effective way to use TARP funds,” Mr. Paulson said.

Instead, Treasury will step up its program of injecting capital directly into banks and, for the first time, expand it to include financial companies that are not federally regulated banks or thrifts.

Mr. Paulson made it clear he would not use Treasury money to help bail out the automobile industry, rebuffing pleas from General Motors, Ford and Chrysler as well as from top House and Senate Democrats.

But Mr. Paulson left open the prospect of providing backdoor support to the car companies by offering to recapitalize nonbank financial companies like GE Capital and CIT Financial, and the financing subsidiaries of Ford, Chrysler and G.M.

House Democrats are already drafting legislation that would provide Detroit’s Big Three with an additional $25 billion, on top of $25 billion in low-interest loans that are supposed to be used for retooling factories for energy-efficient cars.

“The consequences of a collapse of the American automobile industry would be particularly troublesome,” said Barney Frank, Democrat of Massachusetts and chairman of the House Financial Services Committee. Mr. Frank said the assistance would come with strict conditions aimed at protecting taxpayers.

Some Republican lawmakers have already objected, saying the effort would amount to throwing good money after bad. But the White House on Wednesday left the door open to a legislative compromise with Congress.

“I know the automakers are important to the United States,” Mr. Paulson said. “We care about the automobile industry.” But he cautioned that “my focus is on the financial sector — getting credit going, getting lending going.”

White House and Treasury officials have been devising policy on the fly for months now, as what began as a panic over losses on subprime mortgages broadened into a crisis that wreaked havoc on Wall Street, at major commercial banks and in the broader economy itself.

In September, Mr. Paulson went to Congress and urgently pressed for authority to spend as much as $700 billion to unclog the nation’s financial pipelines by buying up unsellable securities from banks and other financial institutions.

But by the time Congress approved the bailout law in early October, Mr. Paulson and the chairman of the Federal Reserve, Ben S. Bernanke, were already shifting to a strategy he had actually opposed: buying equity stakes directly in American banks, a move that was reminiscent of European-style nationalization.

As recently as a few days ago, Treasury officials insisted that they still intended to buy up the troubled assets. But by late October, it had become clear that Plan A had become little more than a sideshow.

“Illiquid assets looked like the way to go,” Mr. Paulson told reporters at a news conference on Wednesday. But as economic and financial conditions declined so rapidly, he said, that he had to change gears. “I will never apologize for changing the approach and the strategy when the facts change,” he said.

The change in strategy has had only limited impact on the frozen credit markets. The biggest improvement has been in the willingness of banks to lend to each other, a change that largely caused by the willingness of both the United States and European governments to guarantee bank deposits and interbank loans.

But the market for commercial debt backed by consumer and business loans has remained at a near standstill since Lehman Brothers, one of Wall Street’s leading investment banks, collapsed in September.

Borrowing costs for credit card issuers are at least five percentage points higher than they were before the credit crisis began. Financing costs for automobile lenders are even higher. Even student loans that are guaranteed by the federal government have been difficult to finance.

“You have a market that is frozen,” said Alex Roever, an analyst at JPMorgan Chase.

To stretch his resources, Mr. Paulson told reporters he was examining ideas to have private investors contribute capital alongside Treasury.

Mr. Paulson also made it clear he did not want to use bailout money to refinance the mortgages of homeowners who are in danger of losing their homes to foreclosure. Democratic lawmakers and the chairman of the Federal Deposit Insurance Corporation, Sheila C. Bair, have been calling for the Treasury to spend $40 billion in a broad mortgage refinancing program.

As envisioned by Treasury officials, the Federal Reserve would set up a new special-purpose lending entity, which would lend cash to investors or companies that put up collateral in the form of consumer loans. The Fed might lend up to 80 percent of the value of those loans, providing a cushion for taxpayers against losses.

The Treasury would contribute 5 percent to 10 percent of the money to finance the lending. But the Fed would raise most of the money by selling what is known as nonrecourse commercial paper to investors.

Treasury officials said the plan would allow them to leverage the government’s money by as much as 20 to 1, meaning that the Treasury would provide 5 percent of the money and investors would provide 95 percent. Using $50 billion in money from the government rescue program, they said, could thus underwrite $1 trillion worth of lending for consumer loans.

Such an arrangement would bear a similarity to exactly the highly leveraged, and eventually disastrous, special-investment vehicles that banks like Citigroup created in countless numbers to hold, among other things, securities backed by subprime mortgages.

Although the Treasury would contribute only a small share of the money for such a program, analysts said the plan would only overcome investor fears if the Treasury or the Federal Reserve provided some kind of backstop against losses. If that were to be the case, taxpayers would be indirectly liable for the entire volume of lending.

Fed officials appeared to be taken aback by Mr. Paulson’s public reference to the idea, and cautioned that it was still in early development.

“Both the structure and the parameters are under discussion and development,” said Michele A. Smith, a spokeswoman for the Fed.

Eric Dash contributed reporting.

A version of this article appears in print on , on page A1 of the New York edition with the headline: Bailout Effort Shifting Focus To Consumers. Order Reprints|Today's Paper|Subscribe